Can anyone seriously believe that if crude oil prices remain near current levels and gasoline subsequently stays closer to $4.00 that the Fed is going to actually attempt to shrink the size of its balance sheet by selling off Treasuries which will have the effect of lowering bank reserves and pushing up interest rates? How does one think this will impact the moribund real estate sector which stubbornly refuses to respond to stimulus? If you think the rate of job hiring is anemic now, just wait and see what happens if interest rates start moving higher on some supposed withdrawal of liquidity.

The other last point I wish to make and is a bit unrelated to this but is relevant – The unstated purpose of the Fed’s QE2 program was to keep interest rates low to LOWER BORROWING COSTS for the US federal government. When your national debt is over $14 TRILLION and rising, when annual budget deficits are above the $ ONE TRILLION mark and the rate of economic growth is not generating sufficient tax revenues to give any hope of seriously closing these budget deficits in the immediate future, it becomes a simple exercise in math that the cost of servicing this huge sum of debt is far easier in a low interest rate environment. When you dealing with numbers of this magnitude, a measly 1% raise in rates carries enormous consequences for US borrowing costs and interest rate payments.

I am not so sure that Mr. Bernanke would long hold his current position were he to actually attempt to withdraw any liquidity by shrinking the balance sheet of the Fed. If he were foolish enough to try in the current environment, every politician in the country would take aim at him with both barrels and begin blaming their budgetary woes and any economic woes on rising interest rates. What a convenient scapegoat he would then become.

The situation is that the Fed is stuck. It cannot withdraw any liquidity without creating an entirely new set of problems that would more than likely have to be once again dealt with by adding more liquidity and repeating the cycle. Lather, Rinse, Repeat!